2
“bolla” del millennio e psicologia degli azionisti (R. Shiller) Others sharply disagree with these bubble stories, and it is precisely this intimation of foolishness that seems to bother them. It seems to them just implausible that investors at large have been foolish. Rather, it seems to them that the high valuations the market has placed on the stock market recently can be attributed to actions of rational investors who are wrestling with hard-to-interpret evidence about such issues as how much recent technological innovations will promote future economic growth. Suggesting that investors at large have been irrational seems arrogant and presumptuous.

3
One of the most important arguments that it is not foolishness that has brought us the high valuations in the aggregate market is to observe the decisions of some of the most august of investors, the real experts. One may note, for example, that those who manage university endowments had not withdrawn en masse from the stock market before its peak in March 2000.

4
Despite these arguments against calling a bubble, in my recent book Irrational Exuberance I do argue that there has indeed been a speculative bubble in the stock market in recent years. But I argue that the kind of less-than-perfectly- rational behavior that underlies it is not abject foolishness (cioè, non è stata una vera “bolla razionale”, ma è stata comunque una bolla speculativa che, anche se non del tipo “razionale” non è dovuta a stupidità) Moreover, I do not think that it is presumptuous of me (or anyone else) to argue that human error in evaluating the available facts has created the high market valuations, and to argue that it is an error that infects the thinking of some of the most intelligent people in our society.

5
There are many aspects to intuitive probability. One of them is the representativeness heuristic, identified originally by Tversky and Kahneman (1974). They showed that in forming subjective judgments, people have a tendency to disregard base rate probabilities [= le reali probabilità], and to make judgments solely in terms of observed similarities to familiar patterns.

6
I think we can say that investors have overconfidence in a complex culture of intuitive judgments about expected future price changes, and an excessive willingness to act on these judgments.

7
Psychologists have documented that there is a social basis for attention, that is, people tend to pay attention to what others are paying attention to. Not surprisingly, speculative assets whose price has gone up a lot recently gather a great deal of attention. People are more likely to buy assets that have their attention just because they are thinking about them more. Assets that have not had big price increases are less likely to garner the attention.

8
Another part of the mechanism by which the past price increases affect the judgments that are actually made about investing for the future have to do with the feelings of confidence and self esteem that past successes in investing has given successful investors. Success in investing usually involves some acquired skills in understanding the particular category of investment and in the strategy of dealing with it. Acquiring such skills regarding that category increases demand for it. Psychologists Heath and Tversky (1991) have shown through experiments that holding probabilities constant people prefer to bet in situations in which their perceived competence is high.

9
After a bubble has continued for a while, there are many people who have committed themselves to the investments, emotionally as well as financially.

10
Investing for the long term means judging the distant future, judging how history will be made, how society will change, how the world economy will change. Reaching decisions about such issues cannot proceed from analytical models alone; there has to be a major input of judgment that is essentially personal and intellectual in origin. With such a confusion of factors, it is hard for anyone to make objective judgments without being influenced by the recent success behavior of the market and the recent success of investments.

11
The complex judgment that portfolio managers must make about these factors, in turn, is inevitably influenced by the judgments of others. In making major allocation decisions, one almost inevitably winds up trusting to a common view or consensus view about the future. Professionals ultimately must end up generally assuming that what their colleagues believe is true.

12
The news media play a prominent role in generating our conventional wisdom, more so among nonprofessionals, but among investment professionals as well. And the news media are themselves in a fiercely competitive business for survival as news media. They cannot be indifferent to the public resonance with the stories they write. They therefore help reinforce a conventional wisdom in some dimensions, and help change it in others.

13
Stock market price increases generate news stories about new era theories just as much as the news stories themselves do. Stories about new era economics surged around 1997

14
If one believes in efficient markets, one believes that the marketplace of ideas somehow works out optimally, and hence, by inference one might suppose that the prominent theories that appear to move investors’ decisions are based on the best possible information too.

15
Irving Janis, in his book Groupthink about professionals’ herd behavior, refers to a number of reasons why professionals operating in groups may be unwilling to deviate from the group consensus. His book reviewed a number of case studies in which professional groups made serious errors. Janis refers to a tendency for people to try to conform to the consensus of the group in order to preserve their status within the group.

16
In judging whether the stock market remains a good investment despite high price earnings ratios, organizations must somehow judge whether we are entering a new era as some claim. Organizations are fundamentally ill-equipped to make such judgments, just as organizations are ill-equipped to write books on history.

17
One reason that institutional investors may not do better is that they feel that they are dealing with clients who have expectations of them that make it difficult to pursue their own best judgment. The clients expect them to invest in accordance with certain fads. Another reason I believe that the differences are so small is that institutional investors do not feel that they have the authority to make trades in accordance with their own best judgments. Their obediance to conventional wisdom hampers their investment ability. Psychologists have argued that human thinking that leads to action, even individual human thinking, tends to be motivated by qualitative reasons and justifications, rather than abstract weighing of probabilities and scenarios.

26
Problemi della mancata considerazione dell’eterogeneità delle aspettative The empirical literature demonstrates that very often the macroeconomics fundamentals are not able to explain the large and persistent movements of some economic variables such as securities prices or exchange rates.

28
La difficoltà di conoscere come funzione il mondo Indeed, the literature on bounded rationality [= razionalità limitata] has put forward two important criticisms. It is unrealistic to assume that agents know the “economic model”; it seems more reasonable to assume that their expectations are based on time series observations. It has been shown that, in several economic areas, naïve forecasting tends to give more accurate predictions than forecasts based on models even if it cannot as a rule predict turning point. The agents also need to have perfect knowledge about the beliefs of all the other agents in the economy to coordinate their actions on the same RE [RE=sigla per “aspettative razionali”]

29
Cambio dollaro/euro 1 Gen Giu. 2006

30
Challenging the RE [=aspettative razionali] hypothesis leads to two questions. The first question is how we should model expectations given the fact that it is hard to observe or obtain information about [other] individual expectations in real markets. The second question is whether heterogeneity in expectations does contribute to excess price volatility as that observed in stock market or exchange rate. In other words, the question is whether agents are able to learn and coordinate on a RE equilibrium in a heterogeneous world.

31
on which criteria we could distinguish between both groups of agents. Evidence from survey data shows that: at short horizons, respondents tend to forecast by extrapolating recent trends (es. analisi tecnica) while at long horizons they tend to forecast a return to a long-run equilibrium (esempio: analisi del fondamentale) Con quali criteri si possono distinguere le diverse classi di agenti

32
Therefore, they associated the longer-term expectations, which are consistently stabilizing, with the fundamentalists, and the short-term forecasts, which seem to have a destabilizing nature, with the chartists.

33
The behaviour of both groups can be explained in two ways: First, both groups behave in different manner because they have different information sets. Therefore, each agent is acting rationally subject to certain constraints. Even when agents have the same information set they may act differently. This may be the case because either they draw a different set of inferences from the same information set or they have different goals, including different attitudes to contending with risk or uncertainty.

35
Aspettative dei chartisti sul prezzo futuro Chartists base their forecasts on technical analysis, which is mainly a study of past prices to detect patterns that can be projected in the future. They use various extrapolative models that can be summarised under the following general formulation: p ^c t = φ (p t-1, p t-2, …) Ovvero: Δ p ^c t = Φ(p t-1, p t-2, …)

37
Come varia la % α t ? If α is constant over time, this means that the weight of the two groups remains the same However, much evidence supports the possibility of switching: Once the weighting factor α is admitted to be able to vary, it remains to explain how it could change. Several strategies have been adopted.

38
La % delle varie classi the proportion of each class of agents fluctuates due to mimetic contagion phenomena. The probability of switching from one group to the other can be formalize as a stochastic process of random meetings (Kirman, 1993; Topol, 1991) or can be grounded on microeconomic foundations (Orlean, 1995, Lux, 1995,1998, Laurent, 1995). This strategy is based on endogenous switching. Several cases are possible.

39
1.Portfolio managers are considered to be the only persons who actually buy and sell on the market. They form their expectations as a weight average of chartists and fundamentalists. Therefore, they update the weights over time according to whether the fundamentalists or the chartists have recently been doing the better forecasting. 2.The second case is derived from Frankel and Froot (1990a) and from the empirical observation that the relative weight of the two groups depends on the forecasting horizons. For shorter forecasting horizons, more weight is placed on chartists while the opposite is true for longer forecasting horizons. 3.When the price deviates from the equilibrium value (in one sense or the other), the two groups of fundamentalists and chartists are numerically different so their excess demand is not nil and then they influence the price.

46
Conseguenze… Fat tails exchange rate returns exhibit fat tails compared to the normal distribution. This has been observed first by Mandelbrot for prices of commodities. Our model mimicks this empirical regularity We also find excess kurtosis, which is declining with time aggregation This has also been found in reality Thus exchange rate movements in normal times are small Once in a while there is turbulence in the market Our model generates this dynamics.

47
Esempio del cambio PPP-dynamics (= valore di equlibrio del fondamentale) is a strong force Thus, the relation between exchange rate and fundamentals dominates; there is little complexity When shocks are small, exchange rates are mostly within transactions cost band PPP-dynamics (= valore di equlibrio del fondamentale) is weak force Chartist behaviour becomes important because link between exchange rate and fundamental is weak The interaction between fundamentalist and chartist forecasts creates strong non-linearity and thus complexity These features of the dynamics of exchange rates have been confirmed empirically

48
When there are few chartists (a lot of fundis), –profitability of chartism is low; –profitability of fundamentalism is high When number of chartists increase relative to number of fundis –Profitability of chartism increases exponentially –Profitability of fundamentalism collapses

49
There seems to be a self-fullfilling evolutionary dynamics An invasion by chartists creates noise around the fundamental; Noise is what chartists thrive on. Thus the invasion creates the conditions that makes chartism profitable, reinforcing the attraction. Chartists create informational environment which makes it rational to use chartists’ rules. … ma se il prezzo si allontana troppo dal fondamentale aumentano I fondamentalisti e quindi… This does not lead to corner solution, though, because risk also increases when chartists become more numerous.

139
THE FED’S EXIT STRATEGY The Fed’s exit is still in its infancy. Chairman Bernanke first outlined the major components of its strategy in his July 2009 Congressional testimony, followed by a speech in October 2009 and further testimonies in February and March So by now we have a pretty good picture of the Fed’s planned exit strategy.

147
1.In designing its [extraordinary liquidity] facilities, [the Fed] incorporated features… aimed at encouraging borrowers to reduce their use of the facilities as financial conditions returned to normal 2.normalizing the terms of regular discount window loans 3.passively redeeming agency debt and MBS as they mature or are repaid. 4.increasing the interest on reserves 5.offer to depository institutions term deposits, which…could not be counted as reserves 6.reducing the quantity of reserves via “reverse repurchase agreements” 7.redeeming or selling securities in conventional open-market operations.

148
Bernanke (2010a) noted that “the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets,” so that instead “it is possible that the Federal Reserve could for a time use the interest rate paid on reserves…as a guide to its policy stance”

149
As the Fed has noted repeatedly, its special liquidity facilities were designed to be unattractive in normal times, and Item 1 is by now almost complete. The Fed’s two commercial paper facilities (one designed to save the money market mutual funds) outlived their usefulness, saw their usage drop to zero, and were officially closed on February 1, The same was true of the lending facility for primary dealers, the Term Securities Lending Facility, and the extraordinary swap arrangements with foreign central banks. The TAF and the MBS purchase program had been recently completed at that time, and the TALF was slated to follow suit at the end of June 2010.

150
Item 2 on this list (raising the discount rate) is necessary to supplement Item 1 (making borrowing less attractive), and the Fed began doing so with a surprise intermeeting move on February 18, 2010.

151
Note, however, that all these adjustments in liquidity facilities will still leave the Fed’s balance sheet with the Bear Stearns and AIG assets and huge volumes of MBS and government-sponsored enterprise debt. Now that new purchases have stopped, the stocks of these two asset classes will gradually dwindle (Item 3 on the list). But unless there are aggressive open market sales, it will be a long time before the Fed’s balance sheet resembles the status quo ante.

152
Items 6 and 7 on Bernanke’s list, which are two types of conventional contractionary open market operations, achieved either by reverse repurchases (repos) (and thus temporary) or by outright sales (and thus permanent). Transactions such as these have long been familiar to anyone who pays attention to monetary policy, as are their normal effects on interest rates.

153
However, there is a key distinction between Items 1 and 3 (lending facilities), on the one hand, and Items 6 and 7 (open market operations), on the other, when it comes to degree of difficulty. Quantitative easing under Item 1, in particular, wears off naturally on the markets’ own rhythm: These special liquidity facilities fall into disuse as and when the markets no longer need them. From the point of view of the central bank, this is ideal because the exit is perfectly timed, almost by definition.

154
Items 6 and 7 are different. The FOMC will have to decide on the pace of its open market sales, just as it does in any tightening cycle. But this time, both the volume and the variety of assets to be sold will probably be huge. Fed’s decision making will be more difficult, and more consequential, than usual because of the enormous scale of the tightening. If the Fed tightens too quickly, it may stunt or even abort the recovery. If it waits too long, inflation may gather steam.

155
Once the Fed’s policy rates are lifted off zero, short-term interest rates will presumably be the Fed’s main guidepost once again—more or less as in the past.

156
This discussion leads naturally to Item 5 on Bernanke’s list, the novel plan to offer banks new types of accounts “which are roughly analogous to certificates of deposit”. That is, instead of just having a “checking account” at the Fed, as at present, banks will be offered the option of buying various certificates of deposit (CDs) as well. But here’s the wrinkle: Unlike their checking account balances at the Fed, the CDs will not count as official reserves. Thus, when a bank transfers money from its checking account to its saving account, bank reserves will simply vanish.

157
The potential utility of this new instrument to a central bank wanting to drain reserves is evident, and the Fed has announced its intention to auction off fixed volumes of CDs of various maturities, probably ranging from one to six months. Such auctions would give it perfect control over the quantities but leave the corresponding interest rates to be determined by the market. These CD’s cannot be withdrawn before maturity, they do not constitute reserves, and they cannot serve as clearing balances. As a consequence, the new CDs may have to bear interest rates higher than those on Treasury bills.

158
The instrument that Bernanke and the Fed seem to view as most central to their exit strategy: the interest rate paid on bank reserves. Fed officials seem to view paying interest on reserves as something akin to the magic bullet. The Fed’s quantitative easing operations have created a veritable mountain of excess reserves which U.S. banks are currently holding voluntarily, despite the paltry rates paid by the Fed.

159
Now that reserves earn interest, say at rate z, which the Fed sets, banks probably will not want to reduce their reserves all the way back to zero. Instead, excess reserves now compete with other very short-term safe assets, such as T-bills, in banks’ asset portfolios So excess reserve holdings will not need to fall all the way back to zero. Rather, the Fed’s looming task will be to reduce the supply of excess reserves at the same pace that banks reduce their demands for them.

160
There is, however, an alternative view that argues that the large apparent “overhang” of excess reserves is nothing to worry about. Banks will not supply federal funds to the marketplace at a rate below z because they can always earn z by depositing those funds with the Fed. Once the relevant market interest rate (r) falls to the interest rate paid on reserves (z), the demand for excess reserves becomes infinitely elastic (horizontal) at an opportunity cost of zero (r – z = 0), [Fig.6]